Expanding the Need For a Fudiciary Standard

Yesterday I noted that the Treasury Department has posted the Obama administration’s proposals for financial regulatory reform. In the midst of all the information that’s there, I missed an important detail. The administration’s white paper, Financial Regulatory Reform: A New Foundation, calls for the fiduciary standard to be applied to broker-dealers. This would be a landmark change from current practice.

Page fifteen of the report states that “The SEC should be given new tools to increase fairness for investors by establishing a fiduciary duty for broker-dealers offering investment advice and harmonizing the regulation of investment advisers and broker-dealers.” Back in March, I noted that SEC head Mary Schapiro had indicated her support for a fiduciary standard in an interview with the Wall Street Journal’s Jason Zweig.  This was a significant reversal from the position she took when she was in charge of FINRA.

The paper is even more explicit on this point than Schapiro was at the time (p. 71):

Retail investors are often confused about the differences between investment advisers and broker-dealers. Meanwhile, the distinction is no longer meaningful between a disinterested investment advisor and a broker who acts as an agent for an investor; the current laws and regulations are based on antiquated distinctions between the two types of financial professionals that date back to the early 20th century. Brokers are allowed to give “incidental advice” in the course of their business, and yet retail investors rely on a trusted relationship that is often not matched by the legal responsibility of the securities broker. In general, a broker-dealer’s relationship with a customer is not legally a fiduciary relationship, while an investment adviser is legally its customer’s fiduciary.

From the vantage point of the retail customer, however, an investment adviser and a broker-dealer providing “incidental advice” appear in all respects identical. In the retail context, the legal distinction between the two is no longer meaningful. Retail customers repose the same degree of trust in their brokers as they do in investment advisers, but the legal responsibilities of the intermediaries may not be the same.

The SEC should be permitted to align duties for intermediaries across financial products.  Standards of care for all broker-dealers when providing investment advice about securities to retail investors should be raised to the fiduciary standard to align the legal framework with investment advisers. In addition, the SEC should be empowered to examine and ban forms of compensation that encourage intermediaries to put investors into products that are profitable to the intermediary, but are not in the investors’ best interest.

This is precisely what consumer advocates have been saying for years.  It will be interesting to see how this all plays out, because brokerage firms have not wanted to be held to fiduciary responsibility.  It’s virtually impossible to sell a product and act as a fiduciary simultaneously.  Moreover, under the present standard, brokers have been free to sell securities in their own firm’s inventory, even if they happened to be securities that the brokerage firm was eager to unload.  If the final legislation is drafted in a manner that provides no loopholes for the brokerage industry, it will be a huge win for consumers.  But…

Congressmen like Senator Charles Schumer of New York (vice-chair of the congressional Joint Economic Committee) will be lobbied long and hard against full implementation of this standard; we’ll just have to see what happens when the legislation is finalized.

About the author

Thomas Fisher, CFP®

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